A more aggressive Jerome Powell has finally admitted the Fed might have been wrong on inflation.
With consumer prices running at their hottest in almost 40 years… and producer prices rising at the fastest pace on record… the Fed chair promised to start taking action.
Today, I’ll detail which steps the Fed is now prepared to take to cool the economy… explain why inflation might prove hard to kill… and give you a low-risk way to protect your portfolio from its detrimental effects.
Let’s start with the news…
At the end of its December policy meeting, the Federal Market Open Committee (FOMC) told us inflation might be getting out of control.
That’s not news for anyone who’s been paying attention… paying bills… or grocery shopping.
What’s new is that the Fed’s now willing to act.
It’s going to sharply accelerate the taper (or slow the rate of its bond purchases)… stopping purchases altogether by March 2022, if all goes according to the new plan.
Previously, tapering was scheduled to go on until June. This acceleration of the timeline will clear the way for long-awaited interest rate hikes: FOMC members now expect three hikes in 2022, three more in 2023–and three more in 2024.
Except nothing here is set in stone.
The financial sector—typically a beneficiary of higher rates—ended only marginally higher on Wednesday (up 0.3% vs. 1.6% for the S&P 500).
The market—and the banks—didn’t fully believe the Fed… and don’t seem to expect drastically higher interest rates any time soon.
And this means inflation is going to stay with us for a while.
The consequences range from further weakness in high-growth stocks… to a slower profit growth rate for major companies… to market selloffs…
So how can you prepare?
Traditionally, bonds have been used as market hedges because they tend to move in the opposite direction of stocks. That’s why financial advisors often recommend the so-called “60/40” portfolio).
But bonds are not the hedge they used to be. The inverse relationship between stocks and bonds has essentially broken down, thanks to the Fed’s zero-rate policies…
Typically, stocks and bonds benefit from different market conditions: stocks rally when everything is great… but investors hide in the safety of bonds when the market turns south.
In our ultra-low rate environment, this relationship has been turned on its head.
Both stocks and bonds have benefitted from historically low interest rates. Stock investors love low rates because free money means more risk is rewarded… And bond investors have no choice but to keep paying more… because bond prices move inversely to interest rates.
Bonds, therefore, will fall if interest rates increase. When the Fed starts to fight high inflation, buying bonds will not be the safe trade it used to be…
But there is one group of bonds created for this environment…
My favorite bonds for inflation protection
Treasury inflation-protected securities (TIPS) are a special type of U.S. Treasury bonds… designed to deliver interest income that keeps up with the level of inflation.
First created in 1997 amid inflationary concerns, TIPS are now offered in 5-, 10-, and 30-year maturities.
The principal of a TIPS bond increases with inflation and decreases with deflation (as measured by the Consumer Price Index)… At maturity, a TIPS bond will pay the greater of either the adjusted principal or the original principal.
TIPS pay interest twice a year at a fixed rate. But because the rate is applied to the adjusted principal, interest payments will also rise with inflation (and fall with deflation).
And because these are issued by the U.S. Treasury, they’re one of the safest assets around.
So in inflationary environments, TIPS can be a better alternative to cash.
One of the easiest ways to own TIPS is through an exchange-traded fund (ETF). Among those, I especially like the iShares TIPS Bond ETF (TIP) and the Schwab U.S. TIPS ETF (SCHP).
Over the past decade, these two ETFs delivered a 30%-plus total return (including dividends). This was better than cash… helping your portfolio keep its buying power.
TIPS are a simple, low-risk way to hedge against inflation and protect your purchasing power—regardless of the next step the Fed takes.
P.S. For two more of my favorite inflationary hedges… and two of the best stocks to own as inflation soars, get my FREE special report: The Inflation Playbook: These 4 Assets GROW Your Wealth During Mass Inflation. Enter your email here… and I’ll send it straight to your inbox.
